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Update from Research Desk on the Second Bi-Monthly Monetary Policy Statement, 2014-15
June 3, 2014

This is a brief update on the Second Bi-Monthly Monetary Policy Statement, 2014-15.


Author : Dr. Renu Pothen



Update Monetary Policy 2013-14

As expected, the Central Bank kept the policy rates unchanged in the Second Bi-Monthly Monetary Policy Statement released today. The major monetary and liquidity measures announced were on the following lines.

1. Keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8.0 per cent;
2. Keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL);
3. Reduce the statutory liquidity ratio (SLR) of scheduled commercial banks by 50 basis points from 23.0 per cent to 22.5 per cent of their NDTL with effect from the fortnight beginning June 14, 2014;
4. Reduce the liquidity provided under the export credit refinance (ECR) facility from 50 per cent of eligible export credit outstanding to 32 per cent with immediate effect;
5. Introduce a special term repo facility of 0.25 per cent of NDTL to compensate fully for the reduction in access to liquidity under the ECR with immediate effect; and
6. Continue to provide liquidity under 7-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system.

Consequently, the reverse repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 9.0 per cent.

Dr.Rajan continues to be firm on his stand on inflation but at the same time has made it very clear that if this target is achieved faster than expected, there would be an easing in monetary policy. The stance is clear from the statement quoted here: “The Reserve Bank remains committed to keeping the economy on a disinflationary course, taking CPI inflation to 8 per cent by January 2015 and 6 per cent by January 2016. If the economy stays on this course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance”.

RBI’s views on growth are outlined here: “Contingent upon the desired inflation outcome, the April projection of real GDP growth from 4.7 per cent in 2013-14 to a range of 5 to 6 per cent in 2014-15 is retained with risks evenly balanced around the central estimate of 5.5 per cent .The outlook for the agricultural sector is contingent upon the timely arrival and spread of the monsoon. Easing of domestic supply bottlenecks and progress in the implementation of stalled projects should brighten the outlook for both manufacturing and services. The resumption of export growth is a positive development and as world trade gathers momentum, the prospects for exports should improve further”.

A detailed analysis of the report clearly shows that the central bank is confident of the fact that the economy is on a recovery path and this is the main reason for reducing the SLR. In RBI’s own words, “As the economy recovers, investment demand and the need for credit will pick up. To the extent that this contributes eventually to supply, it is important that banks have the room to finance it. A reduction in the required SLR will give banks more freedom to expand credit to the non-Government sector. However, the Reserve Bank is also cognisant of the significant on-going financing needs of the Government. Therefore, the SLR is reduced by 0.50 per cent of NDTL, with any further change dependent on the likely path of fiscal consolidation”.

Takeaway for Investors

The RBI Governor seemed to be less hawkish than his previous statements and also sounded positive on the measures being taken by the government to improve the manufacturing sector along with the investment climate. As the Governor has maintained a status quo on rates and as there is no clear indication on rate cuts, our advice to investors remains the same. Investors with a one year time horizon can consider short term funds while those with a longer holding period can take an exposure into dynamic bond funds.

Dr. Renu Pothen
Research Head-Investment Advisory Division


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